Hi John,
You sort of answered the question with the data you presented. The
three factors that make up the pricing of an option are:
1. intrinsic value (actual equity $)
2. time remaining. and
3. volatility.
The three vectors are inter-related in the complex mathematical
formula. Change one of those vectors and the other two must adjust
accordinly. In the example you presented, the price of the stock
went from 93 5/8s to 97 1/2s in the same day! Thus, the intrinsic
value (dollar vector value) of the option WAS IMPACTED and increased
the overall value of the option premium. In other words, the time
value was worth less because the $ value was higher!
Understanding the formula, you would see that with the passage of
each day, the time value would grow less, until, at maturity, the
time portion would cease to exist and become zero. At expiration the
option would be valued at whatever intrinsic value it has achieved.
As a rule, options become more speculative as the time value
decreases.
Here is a tip that will increase your odds of buying a better option
or selling covered calls for that matter! It can be used as a
defensive tool or "A CC Cowboy Ringer" for setting up your call
buyers. If you are buying options you MUST KNOW WHAT VALUE REALLY
IS! It's like going to the ROSS STORES.:-) Do you know when a sale
is really a sale. From ROST profits, I would venture to say most
don't. They buy everything. Good thing for us CCers!:-)
In like manner, the purchase of a CALL option should not be picked
by the price of the option ALONE! For a few more dollars you can
lower your NUT and increase your chances of making a profit sooner!
Likewise, if you write CCs think about how to swift more of the
risk to your call buyers. It's not hard to do with practice.
Exam the dynamics below and you will not be sorry! In fact, it will
put more dollars in your pocket!
THE TRUE COST OF A CALL OPTIO TO YOU!
Price of the STOCK AT $93.625
Option ----- Premium ----Stock Price-Strike Price=diff.-Prem.= NUT!
---------- ------------- -------------------------------------
Nov 90 call ----- 14 3/4 --$93.625-$90=$3.625 - $14.75= $-11.125 nut!
Nov 80 call ----- 20 3/4 --$93.625-$80=$13.625- $20.75= $-7.125 nut!
Nov 65 call ----- 32 5/8 --$93.625-$65=$28.625- $32.625=$-4.00 nut!
Nov 60 call ----- 37 1/8 --$93.625-$60=$33.625- $39.00 =$-5.375 nut!
CLEARLY, the best value for the above case is the NOV 65 CALL for a
mere $32 5/8s! Why? Because your NUT is only $4.00 to your breakeven!
After that you are in the money. Now, a $4.00 move on a $93 dollar
stock is approx. a 4% move which is NOTHING! But, the NOV 90 CALL @
14 3/4 has a NUT of $11.125. You would need almost 12% of a move to
breakeven. That is a much lower delta.
The smaller the NUT the greater the Delta! Meaning, for every dollar
move in the stock the option will follow closely dollar for dollar.
Now, if anyone would like to put this into a Excel Spreadsheet you can! I use to do that, but, I pretty much have the formula in my
head and I can usually spot them without much problems.
In closing, I'm putting something together that will quickly give you
an idea which stocks have the potential to move faster up or down in
price. That will allow another way to select stocks if you have to
decide between one or more to write CCs and don't have enough money
for both. In other words, pick a better work horse!
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